(In Spanish here)
As usual it was an irresponsible and perverse performance by Hugo Chavez. The President that likes to go on nationwide TV to announce the most trivial things, from phantom death threats against him to handing out fake loans to people, did not dare to do the same to announce a dramatic devaluation which is a consequence of his own irresponsible policies. But he even dared to call Venezuela’s foreign exchange controls “efficient”, despite the fact that he was taking this dramatic step and that the exchange controls have been not only the biggest corruption racket in the country’s history, but also represented a perverse subsidy to the rich, via preferential rates for travel and the import of some luxury goods.
And as if the old system was not bad enough, Chavez announced a dual Government exchange rate, triple if you take into account the swap rate, devaluing the official rate of Bs. 2.15 per dollar to Bs. 2.6 per dollar, a 20.9% devaluation, which will be applied only to foodstuffs, medicines, machinery and certain remittances abroad. The remainder of imports will suffer a 100% devaluation to Bs. 4.3 per US$, including supposedly travel allowances and airline tickets, although this was not included in the formal announcement.
Based on last year’s imports of goods, this implies that 45.9% of the goods imported will have a price increase of 20.9%, while 54.1% will have a price increase of 100%, for a weighted average of 63.7% for the increase in price of all of the country’s imports. Thus, the inflationary impact of the devaluation will be very high, much higher than the irresponsible estimate by the Minister of Finance that this will only represent a 3-5% increase to the CPI. It is my understanding that technical people in the Ministry of Finance were not even asked to calculate the impact of the devaluation, another demonstration of the primitive nature of this administration.
And as if the devaluation itself was not the result of the irresponsible economic policies of the last few years, the Government guaranteed that this will be only the first of such announcements to come, as it announced that the Central Bank will transfer US$ 7 billion of the country’s international reserves to the development fund Fonden, leaving reserves at US$ 28 billion, while monetary liquidity stands at a record Bs. 236 billion. Just to give you some perspective, the last time the official rate was devalued in 2005, M2 stood at Bs. 46 billion and international reserves were at US$ 24 billion. Thus, at the time there were practically 2 Bolivars per dollar of international reserves with the official rate at Bs. 2.15 to the dollar, while today there are Bs. 8.42 to the dollar with the lowest official rate at Bs. 2.6. (Although the weighted average of imports stands at Bs. 3.51 per dollar)
This is simply unsustainable, you can not increase monetary liquidity (M2) by a factor of 5, while maintaining international reserves constants and expect inflation to go down or the exchange rate to be sustainable at current levels. The laws of economics can be stretched but not violated (or raped really).
Given that inflation was already going to top 30% in 2010 and if we assume that the import component of goods consumed in Venezuela is almost at 50%, then one would expect an additional 30% spike on inflation from the announced devaluation. Not a pretty picture. The impact of the devaluation may be slightly smaller on the poor quantitatively, because since most food imports are done at the lower rate, and the poor spend more of their income on food, they will feel it less, even if still a huge effect.
There is, of course, a third rate, the swap parallel rate, which people think will actually jump on Monday. The Government said it will intervene in that market and that the Central Bank will be allowed to do so. With PDVSA selling dollars at Bs. 4.3, there is less pressure on the oil company to sell dollars in the swap market. But Chavez also said something like “the Government will control (or monitor?) imports with dollars from company’s own resources”. This seems to suggest that the Government may be planning to limit imports that are not made with CADIVI dollars. Just the initial confusion on this issue may actually lower demand in the swap market initially. (But the policy would be suicidal as shortages would soar) Thus, I would epexct a drop at first and then the swap rate is likely to rise, not only because there are more Bolivars out there and less dollars, but because the Government has practically approved the swap rate as a third rate, when it says the Central Bank will intervene, which should give more confidence to those that are still hesitant to buy dollars aggressively at the swap rate.
But additionally, there is the effect of the sharp drop in demand induced by the 60-plus increase in the price of imports. For the first few months, this should relieve some of the pressure in the swap rate as importers are more cautious on how much to import and the consumer contracts.
Combine the effect of the devaluation with that of the banking crisis and the already high levels of inflation and economic contraction and you now have stagflation on steroids and a very difficult political year for the Government. Hugo Chavez who based his popularity on the delay of implementations of realistic economic policies during the Governments of the so called Fourth Republic, has met his own Red Friday. Unfortunately, he is once again attacking the consequences and not the origin of the problems. Even worse, he is exacerbating them once again by removing US$ 7 billion from international reserves.
While it is true that this improves the ability of Venezuela’s industry to export, such exports were down 50% last year and the inflationary impact of the measure itself may block any ability to compete. Recall that many of these exporters, like the Government’s industrial complex, are forced to sell their dollars at the official rate, now Bs. 2.6 per $, while enduring the high levels of inflation of the country.
Finally, about the only positive aspect that this creates is that the country’s debt is likely to enjoy a huge rally in the upcoming days, as foreign investors perceive that the ability of the country to fulfill its international commitments has improved dramatically with the devaluation. And it has indeed. With this devaluation, PDVSA and the Government will have much more Bolivars, which relieves the pressure on the dollars the Government has, as well as on the need to issue new debt, which is music to the eras of foreign investors. Most investors find Venezuela’s debt quite attractive at even higher levels than these, but it is the specter of the Government issuing new debt constantly that has kept them away from it in the recent past. This eases this concern, at least until the end of the year.
Not a pretty picture for the Government, particularly because this is only a short term solution. Once again, if oil prices do not go up significantly, a year from now, we may be witnessing a similar performance of a new adjustment to the exchange rate. Amazingly, it is incredible that these same measures were not undertaken in September so that their inflationary spike would have been felt last year and not in 2010, an electoral year. The Government now has more money in its hands, but the people will have less, by the end of the year the same distortions and needs of the Government of a month ago, will once again be present.